Sovereign credit risk and exchange rates: Evidence from CDS quanto spreads

Augustin, Patrick; Chernov, Mikhail; Song, Dongho

doi:10.1016/j.jfineco.2019.12.005

Cited by 50 publications

(40 citation statements)

References 57 publications

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“…Du and Schreger (2016) show that the quanto adjustment can explain the large persistent level differences between the local currency and foreign currency credit spreads of emerging market sovereign bonds. Augustin, Chernov, and Song (2018) find that the quanto adjustments of Eurozone sovereigns were substantial during the 2011-12 European sovereign crisis due to the risk of simultaneous EUR depreciation and bond default.…”

Section: Covariance Of Debt Repayment and Fx Returnmentioning

confidence: 86%

“…One potential concern is that the covariance of debt default and currency depreciation can affect the residualized corporate credit spread differential. This default-deprecation covariance, sometimes referred to as the quanto adjustment, has been studied in the sovereign debt context by papers including Buraschi, Sener and Menguturk (2015), Du and Schreger (2016), Augustin, Chernov, and Song (2018), and Lando and Nielsen (2018) 21 .…”

Section: Covariance Of Debt Repayment and Fx Returnmentioning

confidence: 99%

“…With CDS contracts matched for the same firm and contractual terms (doc clause and tier) but different denomination currencies, the euro depreciation-upon-default for each matched pair is calculated as (CDS ($) − CDS (e))/CDS($) (similarly for the yen). The intuition is the following: Suppose Italy's default is associated with a 40% depreciation in the euro, then Italy's euro CDS premium has to be priced at a 40% discount to its dollar CDS in order for the euro CDS buyer to purchase additional contracts and achieve equivalent payout as the 23 Mano (2013), Buraschi, Sener and Menguturk (2015), Della Corte, et al (2016), Du and Schreger (2016), Augustin, Chernov, and Song (2018), and Lando and Nielsen (2018) 24 CDS contracts are written on standardized contract terms categorized by doc clauses that ISDA periodically updates. The most recent update implemented in 2014, for instance, resulted in possible redenomination risk of the euro (Kremens, 2018).…”

Section: Covariance Of Debt Repayment and Fx Returnmentioning

confidence: 99%

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Credit Migration and Covered Interest Rate Parity

Liao

2019

Int. finance discuss. pap.

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This paper examines the connection between deviations in covered interest rate parity and differences in the credit spread of bonds of similar risk but different currency denomination. These two pricing anomalies are highly aligned in both the time series and the cross-section of currencies. The composite of these two pricing deviations-the corporate basis-represents the currency-hedged borrowing cost difference between currency regions and explains up to a third of the variation in the aggregate corporate debt issuance flow. I show that arbitrage aimed at exploiting one type of security anomaly can give rise to the other.

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Section: Covariance Of Debt Repayment and Fx Returnmentioning

confidence: 86%

Section: Covariance Of Debt Repayment and Fx Returnmentioning

confidence: 99%

Section: Covariance Of Debt Repayment and Fx Returnmentioning

confidence: 99%

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Credit Migration and Covered Interest Rate Parity

Liao

2019

Int. finance discuss. pap.

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“…A different type of quanto contract-specifically, quanto CDS contracts-is used by Mano(2013)andAugustin, Chernov and Song (2018) to study the relationship between currency depreciation and sovereign default.…”

mentioning

confidence: 99%

The Quanto Theory of Exchange Rates

Kremens

Martin

2019

American Economic Review

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We present a new identity that relates expected exchange rate appreciation to a risk-neutral covariance term, and use it to motivate a currency forecasting variable based on the prices of quanto index contracts. We show via panel regressions that the quanto forecast variable is an economically and statistically significant predictor of currency appreciation and of excess returns on currency trades. Out of sample, the quanto variable outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk as a forecaster of differential (dollar-neutral) currency appreciation. (JEL C53, E43, F31, F37, G12, G15)

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“…5SeeAugustin, Chernov, and Song (2018) andLando and Nielsen (2018) for recent work explaining why the spreads differ for sovereign CDS contracts quoted in different currencies, based on the correlation between sovereign default and currency depreciation.…”

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confidence: 99%

Central Bank-Driven Mispricing

Pelizzon

Subrahmanyam

Tomio³

et al. 2018

SSRN Journal

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We show that bond purchases undertaken in the context of quantitative easing efforts by the European Central Bank created a large mispricing between the market for German and Italian government bonds and their respective futures contracts. On top of the direct effect the buying pressure exerted on bond prices, we show three indirect channels through which the scarcity of bonds, resulting from the asset purchases, drove a wedge between the futures contracts and the underlying bonds: the deterioration of bond market liquidity, the increased bond specialness on the repurchase agreement market, and the greater uncertainty about bond availability as collateral.

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Sovereign credit risk and exchange rates: Evidence from CDS quanto spreads

Cited by 50 publications

References 57 publications

Credit Migration and Covered Interest Rate Parity

Credit Migration and Covered Interest Rate Parity

The Quanto Theory of Exchange Rates

Central Bank-Driven Mispricing

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